Thursday, July 30, 2015

Union Pacific Corporation (UNP), through its subsidiary, Union Pacific Railroad Company, operates railroads in the United States. Union Pacific Corporation is a dividend achiever, which has raised dividends for 10 years in a row.

The most recent dividend increase was in February 2015, when the Board of Directors approved a 10% increase in the quarterly dividend to 55 cents/share.

The company’s largest competitors include CSX Corporation (CSX), Norfolk Southern Corporation (NSC), and Burlington Northern Santa Fe which is part of Berkshire Hathaway (BRK/B).

Over the past decade this dividend growth stock has delivered an annualized total return of 23% to its shareholders. Future returns will likely be much lower, and will be dependent on growth in earnings and starting dividend yields obtained by shareholders. Investors should also not forget that the transportation sector is exposed to the cyclical nature of the economy, and would follow its short-term cycles pretty well.

The company has managed to deliver a 25.90% average increase in annual EPS over the past decade. Union Pacific is expected to earn $6.39 per share in 2015 and $7.15 per share in 2016. In comparison, the company earned $5.75/share in 2014. The high percentage since 2005 was caused by one-time events artificially depressing earnings, as earnings seem to have been hit by a one-time event.

Earnings per share have also been aided by share buybacks. The number of shares outstanding has decreased from 1.066 billion in 2005 to 883 million by 2015.

As Warren Buffett put it, an investment in railroads is an all-in wager on the economic future of the United States. Over time, the movement of goods in the United States will increase, and railroads like BNSF or Union Pacific should get its full share of the gain. Railroads move goods across longer distances in a much more efficient way that long-haul trucks. This provides railroads a cost advantage.

The economic moats around railroads are the billions of dollars it costs to build them and the fact that the rights of way they need are all but impossible to obtain today. Therefore, it is unlikely that a new railroad will be created, though other modes of transportation could chip away market share.

The annual dividend payment has increased by 20.30% per year over the past decade, which is lower than the growth in EPS. Future rates of growth in dividends will be limited to the rate of growth in earnings per share.

A 20% growth in distributions translates into the dividend payment doubling almost every three and a half years on average. If we check the dividend history, going as far back as 1980, we could see that Inion Pacific has managed to double dividends almost every nine years on average. The item to add however was that in 1998 the company did cut its dividends by more than 50%. Therefore, while the dividend is likely sustainable, this is a cyclical company which is more likely to cut distributions than your typical consumer staples or healthcare dividend stock.

In the past decade, the dividend payout ratio has ranged between 20% in 2006 and a high of 33% in 2014. The high percentage in 2005 was mostly an aberration, as earnings seem to have been hit by a one-time event. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Union Pacific has managed to substantially improve return on equity over the past decade. During out study period, this indicator increased from a low of 7.80% in 2005 to a high of 24.40% in 2014. I generally like seeing a high return on equity, which is also relatively stable or rising over time.

Currently, Union Pacific is attractively valued at 18.10 times earnings, though it has a low current yield of 2.10%. I initiated small position in the railroad, because it is easier for me to track companies when I have skin in the game. I would be more interested in Union Pacific on dips below $90/share. I also initiated a small position in Norfolk Southern (NSC), to which I also plan on adding to on dips.